for creative entrepreneurs

Shark Series: Are Partnerships an Alternative to Investors?

The idea that a creative entrepreneur would ever go on “Shark Tank” is entirely an imaginary thought experiment. Venture capital investors simply don’t invest in professional services companies. Even the best run firms don’t offer the kinds of returns that would entice an investor.

Therefore, as creative entrepreneurs, we remain our own investors. But it sure helps to think about our businesses like a Shark. After all, we may not be in this for extreme profits, but we do want to build strong businesses that will make our efforts pay off.

Finding Help from Business Experts

I’ve mentioned a few times throughout this series that as sole investors, we own 100% of our equity—thus the risks, and hopefully the rewards, belong to us alone. But maybe that’s not the case. Perhaps you’ve brought on a partner—or are contemplating such a move. Since you can’t access the expertise of a V.C. perhaps a strategic partner could help?

This is a common consideration in the creative services business model. In fact, more often than not, when a successful creative begins to have more work than they can handle, looking for a business partner is an obvious next step—especially since most creatives don’t love the business aspects of their work.

But before you go down that road, let’s take some time to think about partnerships like a Shark.

Reviewing the Equity Question

Let’s start with the equity question. When you filled the brief paperwork involved in setting up an LLC, you were the sole member, and thus owned all the equity. If you take on a partner you will be giving up some of that equity. The value of that equity becomes a critical question. Technically, a formal partnership would, by default, be an equal split of equity between the partners. But LLCs allow you to split equity however you want.

Very often when the equity conversation takes place, the negotiations tend to focus on profit distribution. That’s important, but never overlook the control question. If you decide on a 50/50 split, you may end up with serious control problems. If at any point you disagree—and you will disagree—you’ll immediately be at an impasse. Generally speaking, 50/50 partnerships are a crisis waiting to happen.

Who Holds the Reins?

On the other hand, even a 51/49 split puts all the control into the hands of the member with 51%. This is a vulnerable situation for the minority shareholder. While they would have a right to 49% of all profit distributions, when and how much to distribute would be entirely up to the majority owner. A majority owner could decide to increase his own salary (which is an expense to the company—not profit) and up to a certain point, there would be little the minority owner could do. The control question is a serious consideration whenever you think about bringing on a partner.

How Will a Partner “Pay” for Their Equity?

But the value of your equity is also a serious matter. What is your company worth? If you give someone 25% equity, what is the value of that equity? This is not only a matter of negotiation, it also has real-world tax implications. So at some point in the process, you will have to establish the value of the equity you are giving to a partner.

Rarely will your partner be offering cash to secure their share. More typically a vesting schedule is set up, so that they earn those shares over time, perhaps working at a reduced salary over that period as they vest into their equity. Again, to determine such a schedule, you’ll need to establish an honest valuation of the business.

Is Your Equity Worth Much At All?

As I’ve noted a few times throughout this Shark series, when you properly account for the profits of a creative services business and discount any under-compensation to the founder, it turns out that many creative service businesses operate close to a break-even basis. Which means the equity is worth close to nothing.

When that’s the case negotiations shift to what the company could be worth if the new partner is brought on. In which case the new partner will want a sizable piece of equity—especially since its current value is low—and they will take more of the risk that their participation will change the fundamental profitability of the company. Sharks sometimes demand a lot of equity for their investment, especially when they believe a company will never be worth much without their involvement. When they demand high equity they make the point that 50% of millions is worth a lot more than 100% of nothing.

This brings us to an extremely important aspect of forming partnerships in the creative services business: the roles of the partners.

What Are You Looking For From a Partner?

When a creative is overworked, and more and more work continues to roll in, looking for help is the next step, which often takes the form of looking for a partner. But is that person another creative, who can immediately begin producing? Or are they someone who can handle the business side of things? Or do you want a rainmaker who can ensure that the work will continue to flow?

Deciding on which role a new partner will fill is critical. Rarely do you find someone who can do it all. Sadly, when this important decision is made in the midst of an overwhelming business situation, your long-term strategy is not in view. The prospect of immediate help and relief colors the decision-making process. You need to consider your long term goals about how big you want your company to become. If you want a small boutique then another creative with a complimentary skill set might be best. If you want to become a small firm (4-8) then a new business person might be best. If you want to grow beyond that, you’ll need to look for a solid overall business manager.

How Will New Ownership Play Out Over the Long Haul?

Another important consideration is to consider your role in the long run. You may have founded the company, and you may be the primary talent that currently draws new clients, but if you intend to grow into something with a handful of employees or more, those particular contributions will come from staff designers and the new business role.

Imagine a day five years down the road where your business partner is driving the ship, bringing in clients, managing staff, and your role is essentially the same as one of the other creatives on staff. Would the terms that you negotiated on day one seem equitable on day 2,000? If you don’t intend to move up into an equitable management role as the company scales, leaving behind some, if not all, of the hands-on creative work, your partnership may not last.

Equity Does Not Equal Employment

Always remember that owning equity in a business does not entail any right or obligation to work for that business. As someone acquires shares, an agreement ought to include a vesting schedule. But once that is complete, an equity partner could decide to quit their job the next day, and they would still own their equity. A partnership agreement could establish a procedure for selling back equity under such circumstances, but that presumes that you or the company would have the wherewithal to buy the equity back.

Partnerships are not simple. There are many issues to think through. They are no magic bullets to growing your creative practice. So before you start up a conversation with a potential partner, make sure you understand all the implications of what you’ll be getting yourself into. Thank a bit more like a Shark, and don’t underestimate the value of your equity—whether its cash value or the value of overall control.

If you are actively considering forming a partnership, a single issue consulting call could be extremely valuable to help you think through the implications in your particular situation.

Are you ready to take the struggle out of finding new clients?